Telegraph campaign: Why our hugely popular – but flawed – Isa system is
ripe for an overhaul

Today the Telegraph launches a major campaign to fix Britain’s creaking Isa system. Created in 1999, these tax-free savings accounts have become so popular they are almost a national institution, with around 14 million people putting money in every year. But the rules devised by the Government, which built on Margaret Thatcher’s vision for encouraging saving and investing, have barely changed in 15 years – and cracks have started to appear.

Take, for instance, the delays and fees faced by investors who switch accounts to save money, or the pointless restrictions that bar savers from investing for the best returns and lowest charges. The outdated regulations also force pensioners and would-be home-buyers to choose between gambling on the stock market or menial returns to make full use of their tax breaks.

Put simply, policymakers and the industry have left savers battling a set of restraints that worked a decade ago but no longer fit even the modest needs of private investors.

Here we outline the five key areas that require a rethink and offer suggestions for reform. Telegraph readers are invited to support our call for better Isas by sharing their experiences and suggesting how the system might be improved.

The Treasury is mulling over the idea of capping the amount of money savers can put into Isas over a lifetime at £100,000. Instead, it must act swiftly to update antiquated legislation to help the millions struggling to make saving pay at today’s record low interest rates.

In the longer term, such improvements – along with boosting, rather than capping, any savings limits – would help solve the savings crisis younger people face as our population ages.

Why we must unshackle Isas

The Isa (Individual Savings Account) is one of the few treasured areas of our financial lives. It provides tax-free interest on cash accounts run by banks and building societies and tax-free growth on investments such as funds and shares.

Savers increasingly treat Isas as their retirement funds, having become disillusioned with pensions. This is unsurprising considering the incessant government tinkering and a string of scandals ranging from the Maxwell affair and mis-selling of the Nineties to Equitable Life’s collapse in 2000 and the current furore over “rip-off” annuities.

Yet while figures showed an increase in Isa investing last year, savers are still sitting on £130bn in accounts that pay no interest. This figure rose a fifth, or £21bn, in a year.

The reason is a sense of despair over meagre interest rates, which have been driven down by various initiatives to stimulate the economy.

Someone with £100,000 in a cash Isa is more than £4,000 a year worse off than in December 2007, according to Dr Ros Altmann, a former government adviser. On average this customer would earn only £1,090 a year today.

The bad news is that a boost in the run-up to the April Isa investing deadline is unlikely as banks have “no need” for our cash this year, according to analysts.

That leaves one main alternative for those looking to save tax-free: taking on extra risk by entering the stock market. This typically means using an online investment “shop” that provides access to shares and funds.

Such services are booming following the decline of investment advice on the high street. As an indication the scale, Hargreaves Lansdown, Britain’s biggest broker, registered 77,000 new customers in six months last year.

These DIY investors flocking online are discovering an Isa system that in many ways is unfit for their needs.

Change the 'one account’ rule

The biggest impediment to smart investing is the strict limit on how many Isa accounts you can pay into each year.

Savers can put the £11,520 annual allowance into one investment Isa and one cash version each year, with no more than half of the money in cash.

This structure is a legacy of Personal Equity Plans (Peps) and Tax-Exempt Special Savings Accounts (Tessas) – inventions of Thatcher’s government in the Eighties, designed to encourage private investing. The merger of these schemes into Isas in 1999 worked well for many years, but now looks dated.

Permitting payments into just one account of each type stops savers experimenting with innovative new services with small chunks of money.

Take Nutmeg.com as an example. This website builds a portfolio of investments to fit your needs, and returned 2.4pc to 15pc in its first year. Fidelity and MoneyonToast.com run similar services for customers who cannot access or do not want financial advice. Savers using these tools cannot buy funds or shares through ordinary investment shops during the same year.

This “one account” rule also inhibits investors seeking to cut costs. Typically, the cheapest investment shops for buying funds are expensive for share purchases. Outside an Isa, investors can simply open separate accounts for each; within an Isa, this is impossible. Subsequently, those who mix funds, shares and investment trusts are forced to pay higher fees in Isas.

Cash savers also face an annoyance. Banks typically refuse the transfers in of Isa savings to their best deals. Should you open an Isa in April and interest rates rise in May, you could be blocked from moving to a better account. These issues would disappear if HM Revenue & Customs monitored only the total contributions to savers’ Isas, rather than the number of accounts opened.

Allow peer-to-peer lending in Isas

So-called peer-to-peer lending arrived in Britain nine years ago. This asset class allows direct lending to borrowers, cutting out banks for better returns. The typical 5pc to 7pc rate is more predictable than share price growth and the risk to capital is much lower.

As interest rates have plummeted, around 80,000 investors have put nearly £1bn into peer-to-peer. The main providers – Zopa, RateSetter and Funding Circle – have proved safe over several years so far. On average just 1pc of repayments are missed. Even then, Zopa and RateSetter use a fund to cover bad debts so savers receive the advertised return. While there is no Financial Services Compensation Scheme, the loan contract ensures repayments continue if the middleman collapses.

Despite offering a valuable halfway house between cash and shares, such investing within an Isa is not allowed. A rule change would be a boon for savers anxious for higher returns but averse to the risks associated with shares.

The regulators should act swiftly. Any change must be accompanied by the removal of the “one account” rule too. Otherwise, savers will have to choose between peer-to-peer and other investments, which could be unhealthy.

Revamp the broken transfer system

In 2010, banks and building societies were ordered to revamp cash Isa transfers after the Office of Fair Trading reported delays and lost interest.

Since then, switching times have been reduced to 15 days. Telegraph readers still report bungles and experts say the process could take two days, if banks wanted. We urge further improvements.

But a more pressing issue is the chaotic system of trying to transfer an investment Isa account between fund shops. Investors face months of delays due to shabby administration, some of which relies on paper-based forms. During this period investors are left in the dark and locked in, even if shares crash.

This is simply unacceptable. Some firms have implemented electronic transfer systems, but statistics disclosed by one provider suggest it still takes 88 days to switch providers on average.

Thousands face this problem today as they use a price war to cut costs: there is now a £500 a year gap between the cheapest and most expensive investment shops for a £100,000 portfolio.

But while providers are happy to shepherd customers through the door, they have made it harder to leave. A number charge fees of up to £35 to move each fund to a new provider, which beyond excessive.

Give savers one allowance

The fusion of Thatcher’s savings schemes in 1999 was imperfect even then: savers were allowed to move cash Isas to investments, but not vice versa.

Most investment accounts include a cash option, but with pitiful interest rates of 0.1pc or less. So pensioners who can no longer take risks on shares are blocked from a decent retirement income.

As more of us treat Isas as funds for later life, this rule must be scrapped. In addition, limiting the cash Isa allowance discriminates against those with shorter horizons. Someone saving for a house or a wedding is likely to need the money within five years so cannot risk shares. A saver with more than £5,760 to put aside must take this risk or pay extra tax.

The average first-time buyer age is now 30 and rising, while house prices are on the up. The Government can help by letting young people put all £11,520 into cash or shares as they please.

Put Isas ahead of pensions

While savers are limited to £11,520 a year for Isa investment, the Government allows them to put up to £50,000 a year into a pension. This bias is unhelpful.

It would be better to cut the pension allowance slowly and increase the Isa limit in line, for instance, to a £20,000 cap on each. This would encourage saving because Isas are not stained with the distrust associated with pensions.

In October, the Telegraph disclosed how Treasury officials had consulted financial services executives on plans to limit the amount that savers could hold in Isas, with a lifetime cap of £100,000 mooted. This would be a step backwards and must be avoided.

In the long term, we would like to see the Government put Isas at the centre of our financial lives, rather than pensions. This would give many the confidence to invest for their futures – essential if we are to avert a savings crisis.

Peer-to-peer: let it in

A major part of our campaign is convincing the Government to allow savers to invest in peer-to-peer lending within an Isa.

This is a new asset class that generates bigger returns by cutting out the banks, connecting lenders (the savers) directly with borrowers. It would go a long way to helping those suffering hefty cuts to their income due to today’s record low interest rates.

Telegraph readers Bill and Kim Jeffries, pictured, are in full support. The couple have earned around 7pc since 2012 by lending to small businesses through Funding Circle, one of the three biggest firms.

Mr Jeffries, 60, could not afford to take the risk of investing in shares, as he needed to ensure the capital was intact when the thatched roof of their Tudor house in Chichester, West Sussex, needed relaying.

The former finance director for car manufacturer Citroën said: “We were risk-averse but the rates at the bank were so miserable I tried moving some of my savings to Funding Circle.”

Bill and Kim Jeffries

He started with a small portion of money left from taking early retirement in 2008, when the motor industry suffered a grim period. But later he added nearly £10,000.

“I found nothing but success and am so confident now that I’d recommend peer-to-peer lending to friends.

“We are earning far more than on our bonds and are lending to 257 small businesses. I’ve seen how badly the banks are treating sole traders and small enterprises so I’m pleased I did it. My money can also help get the economy back on track. It was important to be able to access the money, should the roof have become urgent.

“Being able to put peer-to-peer into an Isa would be the icing on the cake.”

Funding Circle differs from rivals Zopa and RateSetter, which lend to individuals.

The Telegraph understands that government officials have discussed the possibility of allowing peer-to-peer investing within an Isa. We urge them to implement this as soon as possible.

Comment

Richard Dyson, Personal Finance Editor

There is no better time than now to overhaul and improve the UK’s flagship savings scheme, the Isa.

Investor confidence is growing. There is an appetite to buy into our recovering economy. And as a wider backdrop more people – and more younger people – want to take greater control of their future through actively investing.

Yes, there are headwinds in the form of low rates and market shocks but the changes outlined here are achievable, and in any market conditions. They largely entail alterations to the rules and processes that govern our accounts. Best of all, most of the changes we outline here won’t come at a significant cost to the Exchequer.

We very much want to reflect your views on this issue, so please write to us at Your Money, Telegraph Media Group, 111 Buckingham Palace Road, London SW1W 0DT or email us at money@telegraph.co.uk.

Meanwhile, we are working to expand our investment coverage. In coming weeks you will see regular features where, based on our contact with the UK’s best analysts and portfolio managers, we recommend top funds – including investment trusts – in every key sector. These will form a library of regularly updated tips available always at telegraph.co.uk/investing.

As importantly, we are boosting our analysis of all Britain’s broker services. So not only will this website give you a constant flow of ideas about what to invest in – they will help you decide where best to manage those investments, too.

The Telegraph Investor

Editor's comment:

Priced to be great value for new investors and those with large portfolios.